Ramsey Su: Has Real Estate Bottomed?

Submitted by Rich Toscano on August 7, 2009 - 7:40am

My old pal and foreclosure guru Ramsey has penned another insightful missive that he was kind enough to let me post here on Piggington. I'll let the essay speak for itself, but I will add in regard to the conclusion that I think this shows why the Fed is trapped in the monetization game at this point (and why there is little chance that they will stop until forced to do so). Read on...

Has real estate bottomed?
by Ramsey Su

That is a trick question.  There is no correct answer.  That question is too broad.  A broad answer would be correct and incorrect at the same time, when applied to more specific properties in terms of price, location, type, etc.

That said, it is possible to use a set of criteria to answer that question when the scope is narrowed, using the good old econ 101 stuff - supply and demand.

DEMAND

The current demand appears to be heavily concentrated at the entry level.  Buyers are taking advantage of historic low rates and are not burdened with an existing home/mortgage.  Coincidentally, investors with cash are also active at this level because higher priced properties generally do not pencil well as rentals.

I believe this pool is relatively small.  Economic conditions, especially employment, is not supporting a normal level of household formation.  Many would be first time buyers today had already been sucked into the market during the subprime era and are part of the delinquent statistics.  Those who have already been foreclosed upon will not be qualified to re-enter the pool for a few more years, depending on how diligently they clean up the credit blemish.

Trade up buyers are non-existent.  They will remain dormant until prices start to catch up with their mortgages.  Without building up some equity, there is nothing to trade up with.

SUPPLY

The current supply phenomenon is a first for me, during my 35 years in the business.  Specifically, I have never seen such a huge supply of willing but unable sellers.  Every homeowner with negative equity is an unable seller, at the price that meets demand.  A big chunk of supply has been removed from the market because of over encumbrance, in addition to those who are not willing to sell until they can their price.  It is so strange that the physical inventory is plentiful everywhere and yet, the majority of these properties are not sell-able.

The current supply is created by REOs, short sales and the sellers with ample equity who must sell for whatever reason.  Builders also are unable to supply the current demand, since they may be building at negative net margins.  Consequently, there is an acute shortage of housing for the current demand. 

SUPPLY DEMAND GAP

Once again, this is a phenomenon that I have never experienced.  Normally, when there is a supply demand imbalance, prices will either move up or down to some form of equilibrium.  The current demand is capped by affordability.  The supply cannot voluntarily reduce the price to meet demand, resulting in a huge gap between what demand can pay and what supply can sell at.

With all the ill-conceived modification plans and government intervention to date, this gap is widening.  Instead of gradually closing the gap, properties are removed from the unsellable pool into a sellable pool via foreclosure of short sales.  For example, a property with a $500,000 mortgage is not sellable but if the lender forecloses or agree to a short sale at market price of, say, $300,000, the exact same property becomes not only sellable but high in demand. 

FINANCING

Financing is on life support.  How long can the government support it?

First look at FHA.  Here is the "Highway Trust Fund" bill.  The headline is adding $7 billion to the highway trust fund.  What on earth does it have to do with FHA? Look at Sec. 3 here:
http://thomas.loc.gov/cgi-bin/query/D?c111:3:./temp/~c111THpiWv::

SEC. 3. FHA MORTGAGE INSURANCE COMMITMENT AUTHORITY.

    The item relating to `Federal Housing Administration--Mutual Mortgage Insurance Program Account' in title II of division I of the Omnibus Appropriations Act, 2009 (Public Law 111-8; 123 Stat. 966) is amended by striking `$315,000,000,000' and inserting `$400,000,000,000'.

One little paragraph and FHA insurance received an increase of $85b to $400b. 

If you look at SEC. 4, GNMA got an extra $100b also.  This is the way our government sneak expenses past unsuspecting citizens?  In comparison, the $2b cash for clunker debate seems totally silly.  Bernanke or Geithner can fund that out of petty cash.  Anyway, I digressed. 

So we know that FHA funding is there and will continue to insure loans, many of which will be on the delinquent list for years to come.  For 2009 so far, FHA's market share of mortgage origination is in the 20% range.

For the first half of 2009, FRE purchases and issuances totaled $319b.
http://www.freddiemac.com/investors/volsum/pdf/0609mvs.pdf

Similarly, FNM issued $470b for the same period.
http://www.fanniemae.com/ir/pdf/monthly/2009/063009.pdf

FNM estimates $2.5 trillion of total mortgage origination in 2009.
http://www.fanniemae.com/media/pdf/economics/2009/Summary_072909.pdf

Our forecast for mortgage originations is of course heavily conditioned on Federal Reserve policy. As it currently stands, we expect to see roughly $2.5 trillion in originations in 2009, with more than half of that already behind us, and a decline to around $1.5 trillion in 2010 in the event the Fed ends its mortgage-related programs at the end of 2009, as current policy states. The drop off is almost entirely in refinance volumes as the end of the purchase program will almost certainly bring an increase in both mortgage rates and spreads.

Combined, FRE and FNM issuances totaled $789b for the 1st half of 2009.  At this pace, their combined market share should be about 63% of mortgage originations. 

More worrisome is the fact that this mortgage debt is purchased by Bernanke's printing machine.  For the first half of 2009, the Federal Reserve has purchased $621b of agency MBS, at the pace of over $20b per week.
http://www.newyorkfed.org/markets/mbs/purchasesarchive/purchases_archive.html

Using data above, I am estimating that GOVERNMENT CONTROLLED FINANCING HAS A WHOPPING >80% MARKET SHARE of mortgage financing and THE FEDERAL RESERVE IS PURCHASING OVER 60% OF THESE MORTGAGES.  The significance of the government's role in financing is unprecedented and grossly under appreciated.

This is not monetary policy or stimulus, this is government takeover.  There is no plan for FRE and FNM aside from continuously funding their losses.  We are more than half way through 2009 and the real estate market is completely survived by Bernanke's purchases.  In six months, Bernanke's announced MBS purchase plan would be over.  He is on pace to use up every penny of the $1.2 trillion he printed for this purpose.  What is his exit plan for 2010?

Go back to the demand discussion above -- how much of that demand would vanish if this government financing is not available?  How many buyers would be removed from the demand pool for each fractional increase in mortgage rates? 

CONCLUSION

Has real estate bottomed?  The real estate market is in such a precarious position supported by an unbelievably accommodating Federal Reserve that I find it difficult to call it anything.  The current market is unsustainable, something needs to change.  Bernanke must announce his plan for mortgage manipulation soon.  Geithner is wasting more time and money with silly modifications. 

In my opinion, if Bernanke discontinues his agency MBS purchase plan, the market will collapse overnight.  The suspense will soon be over.

Submitted by WaitingToExhale on August 7, 2009 - 11:04am.

I'm not sure what to make of this write-up. There are lots of important points, but I think the actual conclusion is the author believes real estate shouldn't be at the bottom, but can't figure out whether it is or not due to current and possible future government interference.

Is that the point?

Submitted by sdrealtor on August 7, 2009 - 11:20am.

The point is that we are in a very confusing, frustrating and manipulated market that is not reacting to normal forces nor will it anytime soon.

Submitted by 4plexowner on August 7, 2009 - 11:43am.

the message seems pretty clear to me

the real estate market is only being supported with printing press money - as soon as the printing press money is removed

"the market will collapse overnight"

Submitted by WaitingToExhale on August 7, 2009 - 12:50pm.

4plexowner wrote:
the message seems pretty clear to me

the real estate market is only being supported with printing press money - as soon as the printing press money is removed

"the market will collapse overnight"

So, then the conclusion would be we are at the bottom as long as the government keep pouring money in.

Therefore, since everything we've seen so far suggests that the government will continue to pour money in, then we must be at the bottom!

(for a recent example of the government's behavior, see extension of the cash for clunkers)

Submitted by 4plexowner on August 7, 2009 - 2:07pm.

the conclusion I would draw is that we are in a CON-fidence game - as long as printing press money continues to flow AND the people's confidence can be maintained, the real estate market will continue along its current path

human's are fickle creatures and confidence can be lost overnight

~

one of the points that Ramsey makes quite eloquently is that there are many properties that are un-sellable because the 'owner' is underwater

About half of U.S. mortgages seen underwater by 2011
http://www.reuters.com/article/GCA-Housi...

as more and more properties become un-sellable, the market becomes more and more unstable and the CON-fidence game becomes harder and harder to maintain

~

more challenges to the CON-fidence game:

American Incomes Head Down, Threatening Recovery in Spending
http://www.bloomberg.com/apps/news?pid=2...

Surprise shrinkage in service sector
Quells notion of rapid recovery
http://www.washingtontimes.com/news/2009...

US food stamp list tops 34 million for first time
http://www.forbes.com/feeds/reuters/2009...

~

this snippet from Richard Russell's daily missive is relevant to the CON-fidence game:

"All the currencies of the world are tied to nothing of intrinsic value." -- Cato Institute, August, 2009

Russell Comment -- Sadly, we're working for, and saving with, fantasy concepts (i.e. fiat currencies), units dreamed-up and created by men at institutions that we call central banks.

Submitted by jpinpb on August 7, 2009 - 5:13pm.

That is the question. How long can we pump money into the hole of this bubble? I mean, we have pumped a lot already. And yet the results so far have not really been as dramatic as I would think, considering the quantity spent. I'd say stagnant relative to how much they've thrown at it. Places under 500k move. Even get multiple bids. The higher end seems to be in limbo for the most part, w/increasing inventory.

I have no doubt that the government will try to continue to prop it up. But at what cost? When will they just realize their efforts are not helping, particularly in the long run? If you ask me, the patient is dying and on life support. If you pull the plug, the patient will die. The patient is not breathing on his own.

The printing press is the machine hooked up to the patient, the real estate market.

They need to figure out how to get the patient to breathe on its own and w/all the money they spent already, a better route would have been to get higher paying jobs created. JMO.

In the past 10 years we've basically kept the patient alive w/2 bubbles and a printing press. I can't wait to see how this ends. Create another bubble, but what? Spend like there's no tomorrow?

Submitted by patientrenter on August 7, 2009 - 5:46pm.

jpinpb wrote:
.....If you ask me, the patient is dying and on life support. If you pull the plug, the patient will die. The patient is not breathing on his own.

The printing press is the machine hooked up to the patient, the real estate market.

They need to figure out how to get the patient to breathe on its own and w/all the money they spent already, a better route would have been to get higher paying jobs created. JMO.

In the past 10 years we've basically kept the patient alive w/2 bubbles and a printing press. I can't wait to see how this ends. Create another bubble, but what? Spend like there's no tomorrow?

I couldn't have said it better. As for what's next, I think it has to be inflation. (I hate to even say that in print, because it raises hackles of people who are equally certain that deflation will be the lasting consequence of all this, but I think inflation is the future.)

Submitted by patientrenter on August 7, 2009 - 5:48pm.

This was a great article by Ramsey Su, Rich. Thanks to him for writing it, and kudos to you for bringing it here to us Piggs.

Submitted by Arraya on August 7, 2009 - 6:31pm.

I can't wait to see how this ends

It ends in collapse, like all ponzi schemes...

Submitted by sdcellar on August 7, 2009 - 10:23pm.

patientrenter wrote:
I couldn't have said it better. As for what's next, I think it has to be inflation. (I hate to even say that in print, because it raises hackles of people who are equally certain that deflation will be the lasting consequence of all this, but I think inflation is the future.)
I think you may well be right, but doesn't the money have to end up in our hands? It's gotta be more than just cash for clunkers, otherwise how we gonna buy those twenty dollar loaves of bread?

Submitted by greekfire on August 7, 2009 - 10:48pm.

4plexowner wrote:
the conclusion I would draw is that we are in a CON-fidence game - as long as printing press money continues to flow AND the people's confidence can be maintained, the real estate market will continue along its current path

human's are fickle creatures and confidence can be lost overnight

Reminds me of the video, "Inevitable Collapse of the Dollar":
http://www.youtube.com/watch?v=4n3g5lUgkWk

Submitted by patientrenter on August 7, 2009 - 11:22pm.

sdcellar wrote:
...doesn't the money have to end up in our hands? It's gotta be more than just cash for clunkers, otherwise how we gonna buy those twenty dollar loaves of bread?

Agreed, sdcellar. I lived through the 1970's, and there was stagflation. Inflation was high without much increase in prosperity. So it can happen.

Where might all the extra dollars first show up as inflation? That's like looking up at a dam that's overfilling, and wondering where the spill will begin. It's hard to tell. But here are 2 possibilities.

1. If home prices start reflating (because of so much easy money), then cashout refis, HELOCs, and huge gains on home sales could supply many hundreds of billions of additional spending.

2. If the dollar drops a lot, then import prices (including oil) will increase a lot, causing a knock-on effect throughout the economy.

3. Higher govt spending will outlast the emergency phase we're in

My personal bet is on 2, with maybe some assist from 3 and 1.

Submitted by SD Realtor on August 7, 2009 - 11:45pm.

Absolutely great article.

My money will ride on the Feds continuing the process. This is nothing but a confidence game.

What is it like over 12 trillion the govt has pumped into the game that we know about?

Do people know that this is more then all of the outstanding mortgage debt? Yes that means that the govt could have taken that 12 trillion and paid off every single mortgage in America. That is somewhat staggering isn't it? (Note I got this stat from a colleague so someone can easily correct me if I am wrong)

Anyways I do agree with the outlook from Ramsey. However in no way can I see the existing administration let things crash and burn. They need things bad enough so that people will roll over and crawl to the govt for help while giving away more and more freedom, but not so bad that they will get voted out of office.

Thus they will prime the pump as needed... As long as China plays nice the house will continue to win.

Submitted by CA renter on August 8, 2009 - 1:32am.

Excellent article!

Thanks for sharing this with us, Rich, and thanks to Ramsey Su for his insightful analysis.

Agree that the Fed/govt is not nearly done, and that they will destroy the dollar before we see the end of this.

Submitted by drboom on August 8, 2009 - 6:26am.

Arraya wrote:
I can't wait to see how this ends

It ends in collapse, like all ponzi schemes...

Stein's Law:

"If something can't go on forever, it will stop,"

As far as government manipulation of the market, the $8k first time buyer credit and the Fed's efforts to drive down interest rates combined to raise my maximum purchase price from around $210k last summer to a little over $240k this spring. That's more than 14%, and yes--I took the bait and bought in at $239k. The effect of the tax credit should be more pronounced in cheaper markets.

Submitted by Arraya on August 8, 2009 - 8:26am.

This is not monetary policy or stimulus, this is government takeover. There is no plan for FRE and FNM aside from continuously funding their losses. We are more than half way through 2009 and the real estate market is completely survived by Bernanke's purchases. In six months, Bernanke's announced MBS purchase plan would be over. He is on pace to use up every penny of the $1.2 trillion he printed for this purpose. What is his exit plan for 2010?

This is the biggest bailout right here. The Fed is paying top dollar for MBSs because nobody else will buy them.

Wall Street profitable? Paid back TARP? How much money do they make from the sales of MBSs to the Fed?

On the other side of the equation, wage and employment deflation rule the day. Which makes the whole thing a losing battle.

Submitted by deriving drunk on August 8, 2009 - 9:03am.

Banks have shoveled 13.9T onto the Fed balance sheet.

Another figure I saw was 24T in total backstops and guarantees.

Of course, the outstanding debts far outweigh these numbers. And what happens when 1,2,3,4 trillion dollars of losses are tossed onto the taxpayer as these debts go bad? Just add it to the tab, Mo? We have hundreds of billions of agency debt that *may* be sold over the next weeks and months - these sales will be very telling as to future interest rates.

I don't know why we assume the Fed can print forever just to prop up housing prices. Our extortionists are stupid, but not that stupid.

I will maintain they are only trying to control the crash now underway, not trying to precipitate out of control inflation some of you are literally banking on. They are having some modicum of succes so far in controlling the speed of descent, and I heartily admit none of us knows what will come next as animal spirits can squash rationality. However, I believe in the long run we need to act on rationality and what is "right", not "it's different this time", "buy now or be priced out forever", and "it's a new paradigm!".

Submitted by peterb on August 8, 2009 - 9:09am.

Very nice analysis. Thanks.
These are end-game tactics. Checkmate seems inevitable.

Most mortagaged properties that are underwater have two owners with very different equity positions. The borrower has zero and the lender has 100%. Highly unstable conditions in a downward trending economy.

Submitted by Arraya on August 8, 2009 - 9:11am.

Article from last year...

http://www.bloomberg.com/apps/news?pid=2...

``If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,'' Yu said in e-mailed answers to questions yesterday. ``it is not the end of the world, it is the end of the current international financial system.''

Submitted by patb on August 8, 2009 - 2:12pm.

WaitingToExhale wrote:
I'm not sure what to make of this write-up. There are lots of important points, but I think the actual conclusion is the author believes real estate shouldn't be at the bottom, but can't figure out whether it is or not due to current and possible future government interference.

Is that the point?

Never bet against the Fed.

Submitted by patb on August 8, 2009 - 2:13pm.

peterb wrote:
Very nice analysis. Thanks.
These are end-game tactics. Checkmate seems inevitable.

Most mortagaged properties that are underwater have two owners with very different equity positions. The borrower has zero and the lender has 100%. Highly unstable conditions in a downward trending economy.

no, The Borrower has -10% and the Lender has
90%

very unstable.

Submitted by patientrenter on August 8, 2009 - 2:25pm.

patb wrote:
....The Borrower has -10% and the Lender has 90%...

California is a non-recourse state (and even non-purchase money loans are rarely collected).

So the lender has the risk. The "owner" is only at risk for their own downpayment. Once that is gone, they have no equity and no obligation.

Submitted by John from Doom on August 8, 2009 - 3:48pm.

Worse news at H.4.1 report

More worrisome is the fact that this mortgage debt is purchased by Bernanke's printing machine. ... [and next 3 paragraphs]

I've added a link for this article to my Friday post "Gotcha! The Federal Reserve is a Foreign Central Bank" and Su's work adds a lot of insight to what I'm saying there.

If, as I think, a lot of those Fed MBS purchases have been used to offset continued foreign central bank sales of agencies (and if you think that those sales stopped dead on January 1st like the NY Fed is asserting I'd love to hear a logical reason) then we're in even deeper doo-doo than would be implied if those purchases were merely to keep the market going.

Submitted by John from Doom on August 8, 2009 - 4:00pm.

Hi Arraya, I think I've got a better link here.

"Freddie, Fannie Failure Could Be World `Catastrophe,' Yu Says", by Kevin Hamlin, Bloomberg, August 22, 2008.

A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China's central bank.

This goes back to the farce of an "effective" guarantee on Agency Debt. Note that I'm asserting (below) that the Fed is covering up a continuing flight from agencies that didn't stop on the first of this year (as the Fed is reporting in their statistics). The other side of the coin is that FHFA and the Treasury Dept can't offer an explicit guarantee, because then the OMB would have to report a doubling of America's nominal national debt. Is this a fine mess or what?

Submitted by sobmaz on August 8, 2009 - 5:50pm.

""

You are correct.

The Fed has 90% of the Sheeple believing deflation is the worry. Since it is all about confidence they are lucky people are so gullible.

By the way, a Prescription I take just went up 9.00 and my parents rent up in Portland just went up 9%. My electric charges are up 25% since 2005.

Deflation?

The looming inflation will soften the continued decline in real estate and will reverse the down trend much sooner than otherwise. Inflation will make every asset class rise except interest rate sensitive investments, but none will rise faster than what used to be the only recognized money for 3000 years (except for the last 37), Gold and Silver.

Gold is nothing special, just something shiny. But only something that is limited in supply and is hard to get can work as money. U.S. dollars are being printed by the trillions so are they scarce and limited? Maybe for you but not for the government.

Rocks could be good as gold if there was a limited supply.

Submitted by SD Realtor on August 8, 2009 - 6:03pm.

John and and Arraya I don't disagree with you however I have the full faith that our government can play the shell game longer then you guys think they can.

Your implication of this impending doom seems to be rather open ended.

Submitted by John from Doom on August 8, 2009 - 7:39pm.

SD Realtor,

It's possible they can play this game indefinitely, but there are growing cracks in the facade. This new revelation about the day before Hank and Ben stormed Congress is a big deal.

"Paulson’s Calls to Goldman Tested Ethics During Crisis", by Gretchen Morgenson and Don Van Natta Jr., New York Times, August 8, 2009.

“I operated very consistently within the ethic guidelines I had as secretary of the Treasury,” Mr. Paulson responded, adding that he asked for an ethics waiver for his interactions with his old firm “when it became clear that we had some very significant issues with Goldman Sachs.”

Mr. Paulson did not say when he received a waiver, but copies of two waivers he received — from the White House counsel’s office and the Treasury Department — show they were issued on the afternoon of Sept. 17, 2008.

Even bigger is another recent event. I'm reading this one as an indication that Administration figures realize that, in particular, the High-Frequency Trading market wouldn't survive an independent COMSEC audit, and Larry's got his finger squarely in the dike.

"Security Cyber Czar Steps Down", by Siobhan Gorman, Wall Street Journal, August 4, 2009.

In February, the White House tapped Ms. Hathaway, a senior intelligence official who had launched President George W. Bush's cybersecurity initiative, to lead a 60-day cybersecurity policy review. Ms. Hathaway completed her review in April, but the White House spent another 60 days debating the wording of her report and how to structure the White House cyber post. National Economic Adviser Larry Summers argued forcefully that his team should have a say in the work of the new cyber official.

Even though they've just thrown flash-trading off the back of the troika, I don't think the wolves are going to slow down until they've caught a few more victims. Whole sectors of this system look ready to blow.

Submitted by Arraya on August 8, 2009 - 8:11pm.

sobmaz wrote:
""

You are correct.

The Fed has 90% of the Sheeple believing deflation is the worry. Since it is all about confidence they are lucky people are so gullible.

By the way, a Prescription I take just went up 9.00 and my parents rent up in Portland just went up 9%. My electric charges are up 25% since 2005.

Deflation?

The looming inflation will soften the continued decline in real estate and will reverse the down trend much sooner than otherwise. Inflation will make every asset class rise except interest rate sensitive investments, but none will rise faster than what used to be the only recognized money for 3000 years (except for the last 37), Gold and Silver.

.

Employment and wages are deflating. This is observable and measurable. If those two things keep deflating, how will inflating help anything? The banks are still clogged up and the average consumer is tapped out. The only way to inflate is handing money out.

Personally, I think we are deflating, which will lead to currency problems once the USG can't service it's obligations and has to print. Which will lead to a bond market dislocation and all around chaos.

Submitted by Arraya on August 8, 2009 - 9:01pm.

SD Realtor wrote:
John and and Arraya I don't disagree with you however I have the full faith that our government can play the shell game longer then you guys think they can.

Your implication of this impending doom seems to be rather open ended.

Maybe, maybe not. Personally, I don't think any governments or central banks have that much control over this thing. To me, it looks like a run away train that just past a bridge out sign.

Submitted by SD Realtor on August 8, 2009 - 10:48pm.

Yes guys but it looked like a runaway train in 06, 07, 08 and 09. Now not only is it a runaway train but conductor and crew are spending money at the federal level NEVER BEFORE seen in our time. So do you guys really think the train will be allowed to derail on thier watch?

Furthermore if you want to discuss dislocations never before have we witnessed such a concentration of power given to the treasury via recently passed legislation. That is compounded by a population that is content with giving more authority to a government "take care of them" then ever before as well.

Yes fundamentally it is all looking bad but by the same token it is also fundamentally setting up for a very sustained period of hocus pocus as well. Not only will the power base be sustained but it will grow more. Lobbyist will actually increase thier control as conditions deteriorate. Have you looked at some of the contracts that big pharma is working on right now with the government for the health care legislation?

The more things change the more they stay the same and I believe that as things deteriorate the more we will be told that we need to be taken care of and those presses will be fired up.

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